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The investment manager has another solid year, and interest rates are finally creeping up. That's good for this company.

Investment manager Federated Investors Inc. (NYSE:FII) released its 2015 full-year and fourth-quarter earnings results on Jan. 28, reporting strong double-digit profit growth for the year, and more than 20% earnings-per-share growth in the quarter. The company also saw a larger percentage of its revenues from money markets in the quarter, a product of the small interest-rate increase the Federal Reserve recently implemented.

Total managed assets fell for the full year but increased 3% from the third quarter. Furthermore, revenues from money markets as a percentage of total revenues increased in the quarter. One year ago, money markets accounted for 31% of total fourth-quarter revenues, versus 38% in the fourth quarter of 2015. The biggest driver behind this shift was lower money-market fund yield waivers versus the year-ago period:

Source: Federated Investors earnings release.

The negative impact of fee waivers fell by nearly half in the fourth quarter and has been steadily trending lower over the past year. The full-year impact of fee waivers fell by $33.1 million in 2015. In theory, higher interest rates should further reduce the impact of fee waivers on Federated Investors' revenue and income related to its money-market business.

What happened in the quarter and full year

Fourth-quarter operating expenses fell by 7%, a $10 million savings.

This, combined with the $17 million revenue increase, pushed operating income up 25% in Q4.

Operating expenses for the full year increased 4%, but debt expense fell by nearly half.

Cash and other investments rose again, to $347 million at year-end. This is up $49 million since last year, and $25 million from the prior quarter.

Long-term debt also fell to $191 million, down from $217 million three months prior.

The company took major steps to ready its money-market funds for new regulations, set to take effect in October, announcing its fund lineup in November, and completing a series of fund mergers in December.

Federated is also working on a private placement fund for qualified institutional investors who will not want to or will not be able to use a money-market fund under the new rules.

What management said CEO Chris Donahue, on getting ready for new money-market rules later this year::

"We continue to advance on the substantial effort necessary to position our product offerings well in advance of the Oct. 6, 2016, requirement for floating NAVs for institutional prime and muni money-market funds. We announced our institutional fund lineup in November and completed a series of fund mergers in December."

CFO Tom Donahue, on the expected benefit of the recent Federal Reserve interest-rate increase on money-market revenues and profits:

"Based on current assets and yields, we expect the impact of these [fee] waivers on pre-tax income in Q1 to be about $11 million. An increase in yield of 25 basis points in 2016 could lower this waiver impact to about $4 million per quarter, and a 50-basis-point increase could lower the impact to around $1 million per quarter, and finally an increase in yields of 75 basis points could nearly eliminate these waivers."

For context, the December rate increase was approximately 25 basis points, so if the Fed were to raise short-term overnight interest rates by the same amount for the next three quarters, fee waivers, which negatively affected Federated's before-tax profits $85.9 million in 2015 would be essentially eliminated.

Looking ahead Federated has continued to do a solid job growing its equity and fixed-income investment-management business, and this transition has been hugely beneficial in the low-interest-rate and higher-regulation period that is affecting the money-market business.

However, money markets still make up a sizable part of the business, and fee waivers because of low rates remain drag on profitability. However, it's looking more likely that rates will go up multiple times in 2016, and each rate increase directly raises Federated's profits simply by reducing fee waivers. If rates are increased by 75 basis points by year's end, that would set the company up for a roughly 30% earnings increase in 2017 from last year's results, just from reduced fee waivers.

Whether the rate increases happen before year's end or take longer remains to be seen, but Federated has demonstrated that it can grow its business and profits, even in the current low-rate environment. That's good news for shareholders.

Author

Born and raised in the Deep South of Georgia, Jason now calls Southern California home. A Fool since 2006, he began contributing to Fool.com in 2012. Trying to invest better? Like learning about companies with great (or really bad) stories? Jason can usually be found there, cutting through the noise and trying to get to the heart of the story.
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